Who's Making Money? A seasick industry

Financial results are like the thermometer of any industry.
In the case of liner carriers, the doctor has made a diagnosis, and the patient is pretty sick. Huge losses two of the last three years, escalating debts, and negative cash flow. Those aren’t the characteristics of the worst performers; they’re descriptive of the majority of carriers.
Now just how sick is the liner carrier industry? It depends on who’s making the diagnosis.
Take the most recent three-year period in the container shipping industry, where the vast majority of liner carriers have followed record losses with record profits, then another set of steep losses.
One could either say that the huge profits made in 2010 merely helped alleviate the even bigger losses in 2009. Or, one could say that the losses for most lines in 2011 were more than offset by the record profits in 2010, and that 2009 was an anomaly in which the industry suffered no more unduly than the rest of the global economy.
In this year’s review of the financial health of the liner industry, American Shipper has augmented its focus to look at how debt levels impact the diagnosis, to show more clearly how sick the industry really is. While profits and revenue will forever be the measure of a company’s success, debt levels are playing a larger-than-ever role among carriers, given the high-capital-cost nature of operating a business based on expensive assets.
According to analysis from AlixPartners, a global restructuring consulting firm that has recently launched a maritime practice, the worrying trend for carriers is that debt is increasing while earnings are falling — an unhealthy situation, to say the least. Debt among the top publicly traded lines increased 59 percent from 2007 through 2011, while earnings before interest, tax, depreciation and amortization (EBITDA) fell around 20 percent.
“The last time the industry looked healthy was 2007,” said Esben Christiansen, director for AlixPartners, which collaborated with American Shipper this year to provide deeper analysis on carrier debt levels.
The pressure on the liner carrier industry is palpable. Virtually every single annual report from 2011 had the same refrain — oversupply, rising fuel costs, slow or no growth in the world’s most important economies, all straining cash flow and balance sheets.
Only two of the 15 carriers American Shipper analyzed for this report were profitable in 2011. The 15 lines lost collectively $5.9 billion last year, just two years after they lost $11.3 billion in 2009. The $10 billion of profit from 2010 seems a distant memory, particularly after the top 20 carriers lost upwards of $2 billion in the first quarter of 2012.

Sources: Research by American Shipper, carrier reports.

In the most recent span of five years, 2010 is looking like the anomaly, not a recovery. That’s a significant turning point to the previous five years, when unfettered growth in trades from Asia to North American and Europe allowed lines to bank consistent annual profits.
In the new context, 2008 was a defining year of sorts. That year, 11 of the 15 lines made profits and four made losses. But within those two groups, there were lines that made sizable profits, and ones that scraped by. Looking back, it heralded a new age when profitability only came to lines that sought it, not those that simply expected it.
“Fundamentally little has changed in terms of carrier behavior,” Christensen said. “It’s still very much a game of waiting for rates to improve. Until the oversupply situation is addressed, rate cycles will continue to be volatile.”
The overcapacity situation has plagued carriers — whether by reality or perception — since the global economy went to pot in late 2008. Broadly, the situation is this: the largest carriers in the world banked on continued Asia-Europe growth to the extent that they ordered vast numbers of new, behemoth ships that could only practically be deployed on that trade.
With Europe mired in a debt crisis and these ships steadily being delivered, there is an overhang of capacity that is hard to deny. With an industry just fragmented enough to drive destructive price wars, the threat of capacity flooding individual trades always looms.

The Bad. It’s hard to find a silver lining from 2011, not when capacity leader Maersk Line turned a $438 million first half profit into a $483 million loss for the year. Not when perennial profit-maker Hyundai Merchant Marine lost $243 million, and yet still performed better than 11 other lines. Not when COSCO Container Lines succumbed to a $1 billion loss 24 months removed from a $1.1 billion loss.
COSCO has now had operating losses of $1.6 billion over the past three years. Given that the parent company, the China COSCO Group, had a net loss of $426 million in the first quarter, it’s likely the liner business suffered another loss in that period, which projects out to a nearly $2 billion loss in less than 40 months.
The Chilean line CSAV cratered to a $959 million operating loss in 2011, and has lost $1.5 billion over the past four years. NYK Line had $524 million in losses in 2011, and has lost $943 million over the past four years. Maersk, despite netting record profits in 2010, is now in the red over the last 13 quarters, thanks to a $571 million loss in the first quarter of 2012.
How is this sustainable? The short answer is that it isn’t. Layoffs are occurring at Maersk and APL, with other lines sure to follow. A steady stream of shareholder support, whether through cash injections, rights issues, or bond sales, has been required by a number of carriers.
Lines have shown an inability to string together consecutive years of effective capacity management, good rates, and thus profitability. In their search for greater scale, they’ve largely abandoned the basic principle that defines well-run companies — the need to make money.

Sources: Research by American Shipper, carrier reports, Drewry.

The Ugly. Part of the problem, AlixPartners argues, is that the industry is screaming headlong toward commoditization.
“In their effort to reduce costs, carriers have inadvertently increased the commoditization of the industry,” said Brian Nemeth, AlixPartners’ vice president. “Initiatives such as slow steaming and more port-to-port lanes have narrowed the performance gap between carriers and created more price pressure on rates. And the NVO (non-vessel-operating common carrier) industry’s increasing role as consolidator and value adder has furthermore strengthened the perception that carriers are primarily capacity providers.”
In that context, he said it makes sense that lines would be so narrowly focused on building bigger, more efficient vessels.
“I would agree that in a commodity interest, scale and cost leadership is key to success,” Nemeth said. “With that background, bigger means better. That said, it is likely that niche operators focusing on speed, customization, or other unique differentiators will emerge.”
But the big ship focus is at the heart of the industry’s debt issues.
The maritime analyst Alphaliner estimated in April that total short-term funding needs for container lines could reach $20 billion in 2012, based on the companies’ estimated debt repayment and finance requirements this year.
Alphaliner said half of the 17 lines it analyzed were unable “to service interest payments from their operating cash flow and had to raise cash from selling shares, raising additional debt or through assets disposals.”
Nemeth said these concerns lead to a new question: who funds the next cash infusions for carriers if rates don’t rise?
“Several carriers did not build sufficient cushion in the latest upswing in rates,” he said. “Should current rate levels deteriorate, several carriers will face liquidity and/or covenant issues. The big question is whether lenders, governments or maybe even private equity, as seen in other segments, will emerge as capital providers and avoid restructurings.
“I would argue oversupply is the biggest challenge for carriers currently,” Nemeth continued. “That is a large driver of low rates. Carriers have spent the last few years focusing on cutting costs and some have been more successful than others. But as long as the supply of tonnage keeps outgrowing demand, it will be an exercise in game theory — can the carriers stay strong with their rates and increases, or will they begin to cut the rates to get market share or desired vessel utilization?”

Sliding Rates. Consider this: the oft-repeated phrase that container rates have changed little in the last three decades is particularly worrisome for carriers because the cost of operations has certainly not been so stagnant.
Volumes have increased several-fold since the 1970s, but there’s a point at which quantity doesn’t offset low margins. The core ongoing cost of vessel operations — bunker fuel — has zoomed up in recent years. Ships, though at relatively attractive prices now, are pricier than they were decades ago. But the rates have not kept pace with those increases.
Underlying all of this is debt, which indeed might be the buzzword for the coming years if rates don’t climb back to more profitable levels on key trades.

Sources: Research by American Shipper, carrier reports, Drewry.

AlixPartners calculates that for the parent companies of the 15 lines American Shipper analyzed collective group debt has risen from around $56 billion in 2007 to more than $90 billion in 2011, a rise of 59 percent. Collective group revenue during that same period has risen only about 7 percent.
It’s not shocking if you look at the numbers. Rates — the single method that lines have to generate revenue — have stagnated and debts have skyrocketed. That has created deep problems at companies accustomed to down years being followed by a series of good ones.
“Over the past six to seven years, the container industry has not been creating shareholder value, and that’s a problem for the whole industry,” Maersk Line Chief Executive Officer Søren Skou told American Shipper in an April interview. “We’ve taken out costs, but we’re not creating a return for our shareholders.”
Yet shareholders keep propping up these businesses that have been largely unkind to them.
“Despite the absence of profits, there is still significant shareholder support for all the major carriers,” Tan Hua Joo, an executive consultant at Alphaliner, told American Shipper. “We have seen fresh capital injections at CSAV and Zim in recent months, despite the fact that both carriers have destroyed significant shareholder value in the last 5 years.”
Perhaps no statistic is more striking from this year’s analysis than this: the 15 lines now analyzed by American Shipper for this report collectively lost money over the past five years. Those losses totalled $116 million, but are realistically much higher, given that “K” Line’s liner profits weren’t broken out from their group profits until 2009. If we realistically deduct around $1.7 billion in liner profits from “K” Line over those two years, the 15 surveyed carriers then lost around $1.8 billion over the last five years.
That’s an astonishingly poor performance for shareholders over a medium-term span. It becomes harder for carriers to simply argue that anomalies and uncontrollable factors are adversely affecting their performances in given years. It is verging into poor long-term profit management.
Over that five-year stretch, one line stands out — OOCL has made at least double the profits of every other publicly-traded carrier save for Maersk Line, which is five times bigger in terms of revenue. In fact, separate OOCL, Hyundai, Hapag-Lloyd, Evergreen, and Maersk, and you have 10 individual lines that have been unprofitable, to varying degrees, over the five-year stretch.

Two-thirds Unprofitable. Thus, of the top 15 publicly-traded global carriers, fully two-thirds have been unprofitable over a five-year period. Four of those 10 have lost money three of the last four years. Thirteen of the 15 lines have lost money two of the last three years.
And judging from the financials in the first quarter of 2012, the reality is that the five-year horizon in next year’s report will look even worse.
Unless a serious shift occurs in the second half of 2012, many of those lines will have lost money three of four (or four of five) years. It’s hard to characterize the liner carrier segment as anything but unhealthy.
Tan pointed to OOCL as a model to follow.
“OOCL has consistently outperformed the pack, despite their relatively modest scale,” he said. “Good management remains key. I see evidence of discipline only when carriers are pushed to the brink of collapse.”
Lars Jensen, founder and chief executive officer of the liner analyst SeaIntel, said at a liner conference in June that he expects only around eight large global carriers to be in existence in a decade.
“What we anticipate is that by the middle of the 2020s the industry will have consolidated to a point where the current 20 large global players have been reduced to around eight large global players,” Jensen told American Shipper. “We base this on the ongoing consolidation and commoditization of the industry and use this to calculate the level where the industry becomes moderately concentrated to a degree also seen as moderately concentrated in other industries.”
In April, SeaIntel explored another concept — what market share gains cost the top global carriers.
“As the rate war appeared to have a focus on increasing market share, we find that Hanjin was the winner of the rate war — for the simple reason that they gained the most market share globally,” SeaIntel said in its report. “However, the victory was not easily achieved. Comparing their total financial losses to the amount of TEU gained through the increased market share results in a cost of more than $4,000 per TEU won. Maersk Line might not have been the winner of the rate war overall — however the price they paid for each TEU won was significantly lower than other competitors.”
On the far end of the scale was CSAV, which, according to SeaIntel, paid $170,000 for every TEU of market share it won. The Chilean line lost nearly $1 billion in 2011, or more than $300 on every TEU it moved. That was more than twice the losses per TEU as the next worst performer, COSCO, according to American Shipper’s research.
“This idea of cost of market share is not usually one that’s discussed,” Jensen said.
So what do the relative performances of Hanjin, OOCL and Hapag-Lloyd mean? Are OOCL and Hapag-Lloyd betting on the elasticity of the market? Are shippers really so loyal to particular carriers that they wouldn’t go back to those that gave up share, that might have turned down their business if it was unprofitable?
“That’s a big what if,” Jensen said. “What it means is whether these gains and losses are sustainable. It might in the long term pay off if it means you’ve been able to keep the market share you’ve won. For players that traded volume for profitability, if they’re unable to regain volume, then it’s a short-term gain but will hurt them in the long term. But if it turns out that the changes in market share last year are reversed very quickly, it means money spent on winning market share means nothing. Time will only tell.”

Danger Zone. Another measure of the industry’s precarious position is to examine the Z-scores of liner parent companies.
The Altman Z-score is a measure of a company’s vulnerability to bankruptcy. A score of less than 1.8 indicates a high chance of bankruptcy, while a score of 3.0 or higher indicates a healthy position. Scores in the middle indicate moderate distress.

Sources: AlixPartners, Capital IQ.

According to AlixPartners’ analysis of the 15 carriers, 11 had severe distress Z-scores at the end of 2009. But the situation was even worse at the end of 2011, with 12 lines in the danger zone. What’s more, by the end of 2011, the other three lines were in the gray area between healthy and unhealthy.
In 2010, only six lines were in the danger zone, while seven lines dropped into a lower category from 2010 to 2011. The 15 lines, taken collectively, fall into the “severe distress” category with a score that’s actually a tick worse than in 2009.
By another measure, debt-to-EBITDA, the industry looks little better. The debt-to-EBITDA ratio captures at a high level the ability of a company to pay off its incurred debt. The ratio for the 15 lines was 4.4 in 2011, a fairly high number considering it hovered between 2.0 and 2.1 before the economic crisis. The current ratio is well below the 5.8 seen in 2009, but much worse than the 2.8 in 2010.
Alphaliner considers a debt-to-EBITDA ratio of below 7.0 to be healthy, but Nemeth of AlixPartners said anything over four-times EBITDA is fairly high for the liner industry.
“While the industry average of debt/EBITDA at 4.4 times is elevated, far more concerning is that the majority of companies we looked at either had high leverage or had high debt loads and posted negative EBITDA,” he said. “The overall picture resembles conditions in the 2009 recession and suggests that companies have not done enough over the past two years to control costs, drive revenues and trim debt, causing them to continue to be at the mercy of the external environment.”

Sources: AlixPartners, Capital IQ.

Indeed, what these measures show more concretely than our eyes may tell us is how container lines have allowed themselves to become so vulnerable to factors completely out of their control.
Lines have no control over the price of bunker fuel. They can’t control demand. They can’t control port disruptions, or bad weather. They can’t control the strategic plans of other operators (such as vessel ordering). But what they can control is internal costs. They can control the business they seek, and the business they turn down. They can control the investments they make and the debts they incur.
Seven of the 15 lines surveyed by AlixPartners for American Shipper incurred more in capital expenditures in 2011 than they earned in cash from operations. In 2010, only two lines were in such a predicament. In 2007, there were none.

Better Outlook? Despite all that you have just read, there is reason not to be too despondent about the state of liner shipping. Most lines do appear to have an understanding of their situation.
“I would argue, to an extent, carriers do look at profitability,” Christensen said. “The key question is whether they will become better at reducing volatility. But as long as oversupply exists this is unlikely.”
Lines also have shown that shareholders and governments are willing to support them in the direst of times, keeping afloat loss-making and debt-addled companies that might have sunk in other industries.
Which lines will be left standing does not depend on their current financial strength, Jensen argued, but rather “on their ability to get access to additional funds, something all carriers have shown themselves to be very skilled at doing,” Jensen said. “It’s interesting to see how capital raising efforts affect the market share battle.”
And the sheer girth and level of eccentricity of each individual carrier makes it unappetizing for rivals to consider acquiring and integrating one of their competitors, especially in a market where access to funds are limited.
So the present situation — lines struggling to keep above water, but a lack of consolidation — should continue through 2013. Despite all the talk of unpredictability being the bane of shippers’ existences, those shippers have profited from extremely low ocean freight rates in this period. Yes, it’s bad to have prices fluctuate, but is that worse than paying consistently high prices?
Now it’s a question of whether liner woes have infected the rest of the industry, from non-asset operators, to logistics companies, to shippers themselves. Are carriers shooting themselves in the foot, or shooting the whole industry in the foot? As Jensen said, only time will tell.